On 23 February 2022 the European Commission presented its proposal for a Directive on corporate sustainability due diligence. If adopted by the European Parliament and the European Council, the new rules will apply:
- firstly to all large private companies with over 500 employees and €150 million turnover in the EU;
- after two years to companies with over 250 employees and €40 million turnover and where at least 50% of this was generated from operations in high-impact sectors such as manufacturing of food and textiles, wholesale of agricultural raw materials and live animals, extraction of minerals and others.
The due diligence obligations do not apply to micro companies and SMEs. However, the Directive does provide for supporting measures for those likely to be indirectly affected as part of the supply chains of larger companies, for example a requirement for a larger company to bear the cost of any third-party assurance required from a SME to verify compliance with its code of conduct or measures to prevent adverse human rights or environmental impacts in its supply chain.
It is expected that the Directive will apply to approximately 13,000 EU companies and 4,000 third-country companies (non-EU companies operating in the EU).
What are the proposed rules?
The objective is to require companies to:
- implement processes that mitigate the risk of adverse human rights and environmental impacts in their value chains;
- integrate sustainability into their corporate governance and management systems, and
- frame business decisions in terms of human rights, climate and environmental impact, as well as in terms of the companies’ resilience in the longer term.
Companies concerned must have a due diligence policy that is reviewed and updated annually, detailing:
- the company’s approach to due diligence
- a code of conduct describing the rules and principles to be followed by the company’s employees and subsidiaries
- the processes to implement due diligence, including measures to verify compliance with the code of conduct and to extend its application to established business relationships.
Companies are required to conduct human rights and environmental due diligence by:
- putting in place a due diligence policy;
- integrating due diligence into their policies and management systems;
- identifying actual and potential adverse impacts;
- preventing, ceasing or minimising adverse impacts;
- ending, neutralising and remediating adverse impacts;
- establishing and maintaining a complaints procedure;
- monitoring the effectiveness of their due diligence policy and measures;
- publicly communicating on their due diligence.
Business relationships
In establishing the extent to which due diligence is to be applied, there is one approach for the company’s own operations and subsidiaries and another for its business relationships. In relation to the latter, a company’s obligations extend only to established business relationships that are, or expected to be, lasting and that do not represent a negligible or ancillary part of the value chain. There are further considerations in the Directive that apply to a company’s direct and indirect business relationships (e.g. suppliers of the company’s direct suppliers), including circumstances in which a business relationship cannot reasonably be brought to an end.
Combating climate change through strategy, risk and remuneration
Companies will be required to:
- have a plan that ensures their business model and strategy of are compatible with the transition to a sustainable economy and with the limiting of global warming to 1.5°C in line with the Paris Agreement;
- include emission-reduction objectives in cases where climate change is or should have been identified as a principal risk or a principal impact of the company’s operations;
- have regard to the fulfilment of the above obligations when setting variable remuneration, if variable remuneration is linked to the contribution of a director to the company’s business strategy and long-term interests and sustainability.
New directors’ duties
The Directive introduces a duty for directors of EU companies to set up and oversee the implementation of corporate sustainability due diligence processes, including a due diligence policy, and to adapt the company’s strategy to take into account adverse impacts on human rights and the environment arising from their own operations.
The Directive also clarifies the general duty of care requirement in relation to these new rules. Directors are required to take into account the consequences of their decisions for sustainability, including, where applicable, human rights, climate change and environmental consequences, in the short, medium and long term.
Third party assurance
The Directive refers to situations where seeking independent third-party verification is appropriate; for example, verification of compliance with contractual assurances provided by a supplier in relation to meeting human rights and environmental required by the Directive. Independent third-party verification in this context is to be provided by an auditor that is independent of the company, free from any conflicts of interests, has experience and competence in environmental and human-rights matters and is accountable for the quality and reliability of the audit.
Enforcement
A national authority will be designated to supervise and impose effective, proportionate, and dissuasive sanctions, including fines and compliance orders.
Civil liability will apply to companies, directors (in cases where courts decide to lift the corporate veil) and/or senior executives (where legally accountable). Victims may be entitled to compensation for damages arising from the failure to comply with the obligations of the new rules.
The company’s own monitoring measures and compliance functions will play an important role in ensuring effective identification, prevention, minimisation, ending and mitigation of adverse impacts on human rights and the environment. The Directive establishes minimum requirements for monitoring, though companies should also be aware of other measures (e.g. whistleblowing), that can assist in identifying adverse impacts or breaches of the company’s policies and procedures.
Persons who work for companies subject to due diligence obligations under this Directive or who are in contact with such companies in the context of their work-related activities can play a key role in exposing breaches of the rules of this Directive.
Directive in the context of the EU Green Deal and Ireland
This Directive represents a significant step towards achieving a primary objective of the European Green Deal, for sustainability to be further embedded into the corporate governance frameworks of organisations across the EU.
The Directive complements the EU Corporate Sustainability Reporting Directive (CSRD) by adding a corporate duty to perform due diligence. This Directive will underpin the EU Sustainable Finance Disclosure Regulation (SFDR) which requires financial market participants to publish a statement on their due diligence policies with respect to principal adverse impacts of their investment decisions on sustainability on a comply-or-explain basis. The Directive will also complement the EU Taxonomy Regulation, a transparency tool that facilitates decisions on investment and helps tackle greenwashing by providing a categorisation of environmentally sustainable investments in economic activities.
The Directive will also complement several other EU Directives and policies aimed at combatting human trafficking and forced labour, establishing deforestation-free supply chains, an action plan on a circular economy, a strategy for financing the transition to a sustainable economy, and more.
Sustainability in corporate governance, or ‘sustainable corporate governance’, encompasses encouraging businesses to consider environmental, social, human and economic impact in their business decisions, and to focus on long-term sustainable value creation rather than short-term financial value. The value of good corporate governance to long-term sustainable success is not new to companies familiar with the first principle of The UK Corporate Governance Code. While the Directive will apply to large private companies, we can expect that many businesses in Ireland’s small, open, export-lead, economy will be impacted.
Níall Fitzgerald FCA
Head of Corporate Governance & Ethics at Chartered Accountants Ireland
Note: Click for further information on the Corporate Sustainability Due Diligence Directive.
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